On-Premise to SaaS: The Changing Nature of Scale

How the software industry’s transition shifted scale benefits from demand-side to supply-side.

The Shift

In on-premise software, firms benefited from large absolute dollar fixed costs, high marginal profitability, and high customer captivity from switching costs. But the model came with significant variable costs related to consulting and maintenance.

SaaS Changes the Economics

In SaaS, absolute dollar fixed costs were lower, allowing more firms to enter. But fixed costs became a greater proportion of the total cost structure as ongoing consulting and maintenance expenses went away.

The Implication

Neither model is better in the abstract, but changes in cost requirements shift the nature of how scale manifests—from demand-side advantages to supply-side advantages. This in turn changes the source of entry barriers and competitive advantage.